Time to consolidate

The EU institutions are sufficiently strong to contain any potential spill-over from Brexit to vulnerable member states, says the Cologne Institute's director Michael Hüther in a guest commentary for United Europe.

David Cameron and the British electorate have gambled away the United Kingdom’s European future and caused great damage to all players involved. With regards to domestic policy, the Brexit vote is stirring up conflicts both within the political parties and between the four nations that make up the United Kingdom. There seems to be no clear roadmap of how to deal with the surprisingly unexpected outcome of the referendum.

Economically, the British may lose access to the world’s largest single market if their next government takes the referendum seriously and abolishes the freedom of movement and residence for EU citizens in Britain. The European Union, on the other hand, will lose its financial powerhouse and with it the gateway to the Commonwealth, and the closest ally of the United States.

Legally, very little will change during the coming two years. However, this past week’s financial market turmoil has shown how insecure market participants feel about the referendum’s outcome. Investors’ risk aversion has increased significantly. The markets certainly overreacted in the first place, but decline will continue if political uncertainty persists.

The downgrading of the UK’s credit rating also indicates that investors will tend to be very cautious in the upcoming months. European and international companies and investors are likely to reduce their economic engagement. Growth forecasts for the Kingdom have been corrected downwards by up to two percentage points for this year already. Clearly, observers see Britain’s growth path shattered.

Prevent further disintegration

During a time when sovereign borders have lost their economic importance, breaking with the solidarity of the European community, leaving the single market and reinforcing nationalistic populist stereotypes amounts to a political, economic and societal breakdown.

In fact, Brexit comes at a time when it would have been crucial to find a common approach to dealing with the historically high number of refugees coming to Europe. Within the European Union, the UK’s representatives would have been able to put forward their views and ideas and negotiate compromises suitable to their needs. By leaving the Union, they have effectively renounced any ambition to actively shape a globally interconnected digital world with all its burdens and potentials.

The world is troubled already by war and the erosion of borders in the Middle East as much as by an emerging market slowdown around the globe. If Europe were to gradually return to an isolated coexistence of sovereigns, it would send a terrible message. EU representatives have to prevent the Union’s further disintegration. This means that there can be no cherry-picking in the upcoming exit negotiations. Whoever will be in charge of the British delegation should know that there is little room for manoeuvre.

Stop using Brussels as scapegoat

Given the current outcry in Britain, it seems possible to have a pro-European government in place to negotiate the conditions under which the UK will leave the EU. According to the EU treaty, the exit process has to be concluded within two years after invoking article 50. Given the difficulty of the issues, this means that both sides might still be trying to straighten out their future economic and political relations even after the UK will have left the EU in late 2018.

Yet it is in the interest of all parties involved to return to stable trade relationships as soon as possible. Prolonged negotiations raise the probability of a lasting economic slowdown that could spread across Europe. In order to prevent having to sail in uncharted waters for years, preliminary trade negotiations between the UK and the WTO need to start right away. The damage needs to be limited as much as possible – this is no time to seek revenge or point fingers.

Irrespective of the negotiations’ outcome, it has become clear that the response to the rise of radical nationalism across Europe cannot be to push for more integration. Decision makers in Brussels have to consolidate their achievements and stress the value and importance of the political and economic institutions created during the Euro crisis. The EU needs to call on the governments of its member states to demonstrate their commitment to the European project. Too much harm has been done by national politicians who use Brussels as a scapegoat whenever there are unable to face the challenges at home.

In any case, the EU institutions are sufficiently strong to contain any potential spill-over from Brexit to vulnerable member states. Although in the medium and long term, economic growth in Europe will significantly slow down, no resurgence of the financial crisis is to be expected. The financial system has had its time to build up equity reserves, and Brexit has, after all, not come as a complete surprise. The British pound’s depreciation against the euro does imply a certain deterioration of the EU’s competitiveness, however, not to an extent that the economies will not be able to cope with.